Ethereum’s Buterin slams Terra, saying no ‘real investment’ can generate 20% APY

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The aftershocks that followed the collapse of the Terra (LUNA) ecosystem are still being felt in the crypto world. The sudden collapse of a top 10 coin has raised many questions, and some are worried about whether other cryptos and stablecoins – especially algorithmic stablecoins – could also fall apart.

More recently, Vitalik Buterin, crypto guru and mastermind behind Ethereum (ETH), jumped into the debate. He posted a thought piece claiming that you can’t tar all stable parts with the same brush. Buterin points out that certain stablecoin algorithmic models are feasible and explains why.

Buterin’s thoughts on stablecoins

An algorithmic stablecoin is often backed by another crypto and uses built-in formulas to regulate the price. This is different from, for example, USDC, which is a fiat-backed stablecoin backed by real dollars in the bank. The big challenge for all dollar-pegged stablecoins is finding ways to maintain their peg.

Terra used a system that relied on a symbiotic relationship between LUNA and the stablecoin Terra USD (UST). The system basically burned or minted both tokens to maintain the value of the UST. It’s a bit oversimplified, but when the value of LUNA dropped dramatically, the UST stablecoin became unsustainable, triggering a death spiral.

Another issue was that Terra’s Anchor protocol promised 20% APY on UST. Some investors converted their savings into UST to earn the high APY without fully understanding the risks involved. This is one of the reasons Buterin welcomes the increased level of control over decentralized finance (DeFi).

The well-known developer says that when stablecoins attempt to generate these types of returns, they can turn into Ponzi schemes instead. “Obviously, there is no real investment that can bring nearly 20% return per year,” he said. “In general, the crypto space needs to move away from the attitude that it’s okay to provide security by relying on endless growth.”

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But just because Terra’s experiment failed doesn’t mean that algorithmic stablecoins can’t work. Buterin focused on an Ethereum-based stablecoin called RAI, created by Reflexer Labs. It is not pegged to the dollar and aims to become a stable global reserve that is not tied to any individual fiat currency. RAI is collateralized using ETH through a lending system, and Buterin explains how RAI will maintain stable value even in the face of dramatic volatility.

Crypto is not magic

DeFi eliminates the middleman from many traditional banking transactions. It can reduce fees and generate higher returns, but it also carries additional risks. You don’t get the same consumer protections in DeFi as you do with a traditional bank. Some schemes are poorly thought out and others are downright scams.

There is sometimes a tendency to believe that incredible returns are possible in decentralized finance because, well, it’s crypto. What Buterin points out is that we should question these systems and understand how they work.

With regard to stablecoins, he gives the following indications:

  • Look to see if they are constantly dependent on attracting new funds to maintain their rates – if so, the schemes are heading into Ponzi territory.
  • Watch what would happen in extreme conditions. Terra couldn’t resist in the face of extreme volatility. Buterin points out that once collapse seemed likely, it became a self-fulfilling prophecy. It only took a small shock to make the system so fragile that it triggered a collapse.
  • Finally, watch what happens if the stablecoin starts to crash. Can he relax safely? Or will it suddenly collapse dramatically? If a project can’t be completed without burning investors, that should be a red flag.

At the end of the line

The collapse of Terra showed us all that cryptography is still in a very experimental stage and even projects that seem convincing can fail. However, it also highlights the importance of critical reflection on specific projects. Last year, when the crypto industry was on an extraordinary bull run, it felt like nothing could go wrong. Now that the economic crunch is reducing crypto prices, we are starting to see the cracks. Make sure you understand the cryptos you are buying, especially if they promise high returns.

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We are firm believers in the Golden Rule, which is why editorial opinions are our own and have not been previously reviewed, approved or endorsed by the advertisers included. The Ascent does not cover all offers on the market. The editorial content of The Ascent is separate from the editorial content of The Motley Fool and is created by a different team of analysts. Emma Newbery holds positions at Ethereum and Terra. The Motley Fool has positions in and recommends Ethereum and Terra. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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